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For example, a company takes up a bank loan to finance its expansion. The Return on equity over the next for years is as follows.
Year 0 : 15%
Year 1 : 14%
Year 2 : 16%
Year 3 : 18%
Year 4 : 19%Can we relate the drop in the ROE in the first year to : The fact that interest has to be paid before dividends. And in times of profit downturn the company, may have to reduce its dividend payments in order to meet its interest obligations. Therefore, the profits available to shareholders will be lower. Hence, the ROE is lower is the first year but eventually improves as the profit burden becomes smaller as the loan is being repaid. Can we relate it to this ?
The fact that it is owner managed is irrelevant.
Given that it is a bank loan, the interest is likely to be variable and as the interest is higher or lower this could effect obviously the profit available for shareholders.
More likely is the fact that if there is to be an expansion then it is likely to be a few years before the expansion starts generating higher profits – initially it is likely to mean more interest payable without any higher profits.
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